What's the Story behind Household Formations? - June 24, 2013

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Difficult Job Market Suppresses Household Formations, Fed Expert Says

Along with many things that did happen, something that did not happen helped cause the housing market crisis and hamstrung the nation's economic recovery.

What did not happen: many people did not set up new households. Over five years during and after the 2007–09 recession, the number of households established in America plummeted by about 800,000 a year from the previous seven years.

Think of the unemployed or underemployed college graduates living in their parents' basements instead of renting or buying their own place. When a person establishes a residence, whether that's an apartment or a house or another dwelling, that person is forming a household. Mainly because of a weak labor market that held down incomes, the rate of household formation cratered during the recession and subsequent recovery, Andrew Paciorek, an economist at the Federal Reserve Board of Governors, said in a recent presentation that was part of the Atlanta Fed's Perspectives on Real Estate speaker series.

From 2007 through 2011, an average of roughly 550,000 households formed each year in the United States, according to the U.S. Census Bureau. This number was the lowest level since records started being kept after World War II, and was 59 percent below the annual average of 1.35 million household formations from 2000 to 2006.

The graduate in the basement may sound like a cliché. But that phenomenon appears to explain a large part of the fall in household formations, Paciorek indicated. He pointed out that in 2012, 45 percent of 18- to 30-year-olds lived with older family members, compared to 39 percent in 1990 and 35 percent in 1980. That increase translates to several million more young adults choosing to live with relatives rather than to form a new household.

Because of fall in formations, housing provided no spark for recovery
The decline in household formations is the main reason why the housing industry did not play its traditional role of driving the economic recovery, Paciorek explained. After previous recessions, residential investment typically accounted for 1 to 2 percent of annual economic growth, as measured by the gross domestic product (GDP). By contrast, during the first two years of the current recovery, residential investment made no contribution to GDP growth, and has only recent begun supplying a small lift, he noted.

The lack of a housing market boost for the recovery was a direct result of the dearth of new households, Paciorek said. But it was not the only result. The household formation crash also indirectly contributed to other woes, including falling house prices, diminished household wealth tied to lower home values, and weaker demand for expensive goods such as appliances and home furnishings.
The good news is that the job market, and in turn household formation, should strengthen. Along with population growth, a healthier employment situation should push household formations up to about 1.5 to 1.6 million a year over the next several years, according to Paciorek's forecast model. The numbers of formations could exceed the prerecession trend because of pent-up demand for households from those who did not set up homes during the recessionary dip.

There is "positive impetus for housing demand, house prices, and residential construction," Paciorek said. However, he cautioned that his prediction is based on assumptions that could prove overly optimistic and thus comes with "lots of caveats and lots of uncertainty."